I don't understand your cheerleading on low interest rates: wasn't it cheap money that got us into this mess it the first place?!?  This was a comment I got on my recent post, “Rates Fall – Price Dropped - Broker Agent.”  My first reaction was to think, “I’m not a cheerleader.”  Then as I started to think about what my reader said I realized I don’t think low interest rates in the early 2000’s were the driving force behind  the correction or downturn in our Sacramento real estate market and I don’t believe they will play a significant role in any recovery.  At the same time I am not an economist and I am most likely ignoring the relationship between interest rates and the liquidity of the financial market.

What are the factors that lead us to buy real estate?  For most it is the desire to live in a home that we can call our own.  A place where can make changes and improvements that will enhance our investment and pleasure.  I do not equate buying a home with making an investment in the stock market.  There is greater intrinsic value in owning a house than 100 shares of Microsoft or even Google. 

As an investor in rental property, the decision to invest are less emotional and are more like making stock purchase. Investors generally look for property that will produce a positive financial return.  That return may be in positive cash flow or as it was in the early 2000’s asset appreciation and in the best situation positive cash flow and asset appreciation.

Regardless of who is buying real estate, cost is a factor in the buying decision.  The costs of the property as well as the cost to carry the asset are key ingredients to making a decision.  Looking back at the Sacramento real estate market in the early 2000’s I believe the asset appreciation happening at the time far outweighed the cost.  With prices of home going up 20 to 30 percent annually did it really matter if your loan interest rate was 5 or 8 percent or that you were paying more than you should for the property?  As an investor, with a leveraged asset increasing in value at double digit rates did it matter if you could not rent it for what your monthly mortgage payments were? 

In my opinion it was not the cost of money that got us here it was the availability of money.  Twenty years ago the only way to get a mortgage was to make a down payment of 20 percent of the purchase price and prove to the lender that you could afford to make the monthly PITI payments (principal, interest, taxes and insurance).  As prices for homes increased lenders found ways to make the payments lower to help more people qualify for mortgages.  Ideas such as variable rate loans came into being.  As prices continued to grow faster than income and the demand for loans increased, lenders developed more and more programs designed to put people into homes and allow investors to buy more.  Some of these programs have become known as exotic but in-truth it is hardly exotic to give someone a loan for 100 percent of the purchase price and have no documentation to show the borrower can repay the loan.

If the availability of money was a primary cause of the current downturn in the real estate market will the cost of money or lower interest rates be the stimulus to start a market recovery?  My answer is that low interest rates won’t hurt but are not enough on their own to spur any lasting recovery.  Although I personally don’t believe in the proliferation of stated income loans, loans where the borrower does not have document of prove they have the amount of income on their application,  we do need increased availability of loans to spark a long term rebound.

Right now the situation within the lending community is difficult.  Most lenders are taking huge write downs and losses on mortgage portfolios.  Lenders are like people (this is a point that many would disagree with!) and when you get burned by holding your hand over a fire you remove it.  Lenders are being hurt by increasing costs to manage mortgage portfolios and by actual losses.  These losses are causing them to tighten the availability of loans and/or in some cases to cease making loans.  Until they work their way through the problem loans they will maintain much higher or tighter credit standards which means fewer potential buyers will qualify for loans and the loans they get will be less than the purchase price.  Right now loan standard have never been tighter in the 17-year history of the Federal Reserves’ Survey, according a recent article by Doug Duncan.

With this in mind I do believe the lower rates will spur some refinancing activity in 2008 but I can’t see any growth in purchases during 2008.  Hopefully as we move through the year the lower rates will help increase the liquidity in the financial markets and lender who have swung the pendulum from loose to tight will bring it back in some balance between the two and more potential buyers will qualify for mortgages.  Hopefully by the 4^th quarter of this year or early next year we will begin to see Sacramento area housing affordable for more buyers and loans available for them.